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In a time of $1.15 coffee, price risk management is of paramount importance

2015-09-23 Comments

My mother is a first generation immigrant. She came to the United States with my father and three small children in the mid-1980s from the Philippines.  Like many first generation immigrants, she knows the value of a dollar and she rarely pays retail price for anything. A coupon or a sale can always be found. And if prices dropped on something that she had already bought?  Well, she could always return the item and re-purchase it at the new, low price. The generous return policies at stores in the US are my mother’s mitigation against a dropping price against the risk that the item in question could have been bought at a cheaper price. Relatively, the true financial risk my mother faces by paying a bit more for a gallon of milk is really small. The price drop will be measured in cents and it’s a really minor purchase for the household. For a coffee farmer whose livelihood depends on the sale of their crop, a price drop of cents in the global price of coffee can be the difference between just-getting-by and a successful year.

Smallholder farmers face enormous risks due to the volatile price of coffee. A farmer, selling her coffee, unaware of what the global price is, or where the price is trending, or what causes the macro-level changes in prices is often at the mercy of the market. She is a price taker and with definitely less generous return policies that my mother is getting.

A few months ago, the World Bank released a new report on the coffee sector that caught my attention.  Entitled RISK AND FINANCE IN THE COFFEE SECTOR: A Compendium of Case Studies Related to Improving Risk Management and Access to Finance in the Coffee Sector – it takes a look at the challenges facing the coffee sector through the lens of risk and risk management.  I wrote about in a previous post that addressed the unequal investment in the retail side of the supply chain compared to the production side – a direct result of the lopsided and imbalanced exposures to risk.

Coffee farming is filled with risks. Climate Change. El Niño. Depreciating currencies. Roya. I think we have a good understanding of how to (and to what extent we can) mitigate risks from the production side.  However, we need to understand that not all farmers have the means or methods available to deal with production risks. There is still insufficient knowledge of good farm management practices to prepare for droughts or to manage an outbreak of roya.  The risk faced by farmers due to price can be just as devastating as roya or El Niño, causing losses that take years to recover from.  Today’s price (September 16) is $1.16   (the NYC “C” price) is one of the benchmarks used to serve as the base for many producers. They have little to do with the depreciation of the Brazilian real or Colombian Peso… yet unfortunately, their product’s price is tied to this index (Mark Lundy made a great comment about specialty coffee being priced by commodity coffee here). This price is barely above the cost of production in Central America (a rough estimate for Central America is $1.00 to $1.10 per lb that includes the farmers’ own labor).  As we enter the 2015/16 harvest in Central America – I know that all the farmers are nervously looking at the price and praying it comes up.

While the knowledge and methods to mitigating the production risks are more common and discussed – rarely do we get into discussions of mitigating price risk.  Our friends at Fairtrade USA, Keurig Green Mountain, Intl FC Stone, Twin Trading and Sustainable Harvest are the exceptions to this.  They have been some of the first to discuss how to create Price Risk Management tools that work for farmers and cooperatives as well as traders. Price risk management (PRM) refers to a strategy for farmers to minimize their risk to the volatility in prices.  Rather than having enormous swings in profitability/loss – the producer or producer organization can have a more stable income and be able to plan financially.  A popular misconception of PRM is that is exclusively the domain of well financed and organized groups, who are able to utilize the futures market.

How might a PRM strategy look different for an estate vs. a cooperative?  What are some more basic methods of managing more simple tools?  I’m going to be exploring these topics over the next few posts through interviews with some experts and folks who are taking steps to ensure that farmers and farmer organizations are better protected.


— Kraig Kraft


  • Colleen A. says:

    Thanks for this, Kraig. So much truth in your post(s). I wonder about opening up your analogy, though, because I feel like it reinforces this power asymmetry that you reference.

    The retail return policy is surely generous, as you say, yet this generosity is not present in the coffee market. As I’m sure neither you nor I could imagine a producer organization at a Returns Desk willing to renegotiate their contract – even a well-financed cooperative and even with their best, most long-standing customer. Yet this is what happens when the market drops. And here we are saying that producers need training to protect against their downside risk – and they DO – but we must say in the subsequent breath that buyers need to protect themselves too and pay for that option to participate in the price drop.

    I firmly believe that PRM training cannot simply involve estates or cooperatives, but must build themselves into the supply relationships. Producers should cover and buyers should cover, but who pays for and executes the coverage in a given situation? How could risk be shared, especially if there is a loss? It is because of questions like these that my opinion is such that strategies disseminated in trainings will be poorly executed but without incorporating many different nodes of the supply chain.

    • Kraig Kraft says:

      Hi Colleen:

      Thank you for your comment. I won’t claim to have any answers to the questions that you pose. In my next few posts, I have a few different points of view on each of these.

      As for the renegotiation of contracts – I think cooperatives and farmers need to go into negotiations knowing their exact cost of production. At the moment in Nicaragua its between $1.10 – $1.30 per lb.

      I don’t think its good business for a buyer (or the coop/farmer) to agree to a contract that pays below the cost of production. That’s a great way to go out of business and for the buyer – its a great way to lose a supplier.

      As for who pays? I think there are lots of different models and there isn’t an answer that works for everyone. In one of my upcoming posts, we’ll talk to an estate in Nicaragua that hedges almost all of their coffee. Their options are considered part of their operational costs.

      Making this leap requires that you have an entrepreneurial mindset approaching the farm – which is the key to starting any PRM strategy.

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